Sticky Inflation Keeps Markets on High Alert as AI Investment Cycle Continues to Drive Growth

Inflation has cooled down, but its impact on market expectations remains uncertain. Eastspring Investments' CIO bulletin noted that July's inflation data led to a sharp decrease in the implied probability of a September Federal Reserve rate increase from over 72% to 29%. However, underlying inflation remains above target, and price pressures are still moving through the goods pipeline.

Citi Wealth took a more hawkish interpretation, arguing that inflation has moderated but appears to have stalled between 2.5% and 2.75%, rather than returning towards the Federal Reserve's 2% objective. The firm also highlighted that roughly one-third of CPI components are increasing at an annualized monthly rate of at least 5%, compared with around one-quarter before the pandemic.

Wells Fargo Investment Institute emphasized the importance of short-term bonds in limiting volatility due to elevated inflation and uncertainty surrounding oil prices. The firm's preferred response is to limit duration sensitivity through greater emphasis on shorter-term bonds, which provide attractive income without locking investors into as much duration risk.

Eastspring's research found that softer rate expectations combined with exceptionally strong corporate results had moved market leadership back towards growth. More than four-fifths of S&P 500 companies beat second-quarter earnings-per-share expectations, while aggregate profit growth was running at its fastest pace since 2021.